This guide will help you understand the interest-only HELOC better. Home equity lines of credit, or HELOCs, are a type of financing that lenders offer that’s secured by your home. A HELOC calculator tool helps you determine how much you can borrow with this type of loan.
Some HELOCs only require you to make interest payments during the first several years, which leads to the question, “What is an interest-only HELOC?”
How Does an Interest-Only HELOC Work?
As the name suggests, an interest-only home equity line of credit is a type of loan that only requires you to make monthly payments toward the interest on the money you’ve borrowed rather than the principal during the initial draw period. You don’t have to pay down the principal during this period. Draw periods are typically 10 years but can be shorter or longer.
The monthly payments made during an interest-only HELOC draw period go toward lowering the interest amount owed. Once the draw period expires, you’ll enter the repayment period. During this period, you’ll start paying back the principal with interest. Your monthly payments will include your loan’s principal balance and remaining interest. The structure of the payments is such that you’ll have paid off the loan by the time the repayment period ends.
The Top Benefits of an Interest-Only HELOC
The following are the top advantages of using interest-only HELOCs.
Low initial payments
Making only interest payments during the initial draw period can increase the affordability of borrowing cash. Minimal monthly payments ease the financial strain that borrowing places on your household during the first few years.
Flexibility
You can borrow funds, repay them, and borrow yet again as needed during the draw period. If your income is irregular, an interest-only HELOC lets you pay interest only during your low-income periods and make bigger payments as your income rises.
Lower rates
The rates that interest-only HELOCs come with are lower than many financial products, including personal loans and credit cards. You can estimate your interest rate with a HELOC payment calculator.
Tax-deductible
You can make the interest tax-deductible if you use a HELOC to improve your home‘s value.
When Do Interest-Only HELOCs Make Sense?
People may find it challenging to know when an interest-only HELOC is an ideal option for them. There are a number of situations where this type of loan can be perfect.
An interest-only HELOC makes sense if you intend to sell the house before the end of the draw period or if you need money to fund a down payment or closing costs on a property and are planning to sell your previous house soon. You can use interest-only HELOCs if you’re flipping houses and want to minimize the payments on them. If you have a large amount of home equity, you can use funds from an interest-only HELOC on principal payments or investments that earn higher interest.
Generally, an interest-only HELOC can be an excellent option if you need to access cash and expect to have more money or cash flow in the future.
Planning for the Interest-Only HELOC Repayment Period
A major concern with interest-only HELOCs is the monthly payments can go up considerably and be a huge financial burden when the draw period ends. The good news is that you can plan ahead and use several strategies to ensure you handle the principal balance and interest payments more comfortably.
A HELOC payment calculator will be instrumental in establishing and planning your repayment period payments.
After using the tool, you can take these steps to make repayment easier:
- Start paying more than the interest payment before the draw period ends to pay off a portion of your principal balance.
- Consider selling your home and paying off the HELOC with your profits when the draw period expires. You can use leftover funds for a down payment on a cheaper property.
- You can reach out to your HELOC lender to renew your loan.
- If you’re at least 62 years, getting a reverse mortgage can help pay off the HELOC balance.
- You can get a cash-out refinance loan to pay off the HELOC balance.
Now that you know the answer to the question, “What is an interest-only HELOC?” you can use this type of HELOC in a way that will be beneficial to your situation in the short and long term.